What Are Pivot Points in Forex Trading?
You may hear that one of the handier tools in a forex trader’s toolbox is a pivot point calculator. Pivot points are one of the commonly used triggers for trading systems. If you’re new to the forex market, though, you may be foggy on exactly what pivot points are and what they can mean to your trading.
In a nutshell, pivot points are exactly what they sound like – the point at which the market is expected to turn – if it’s been going down, a pivot point is the value at which it will reverse the trend and begin to climb. If it’s been rising, then the pivot point is where the sentiment of the traders will turn and begin a downward trend. Obviously, being able to predict major movements in the money market is a valuable skill, since it hints at the where the market is moving and whether or not this is the time to trade or stick.
Pivot point trading is an especially popular method of mapping out a trading strategy. It was originally used by floor traders in the stock market who liked it because it allowed them to gauge where the market was heading with just a few simple bits of information and calculations. By knowing the high, low, opening and closing points from the previous day, they could calculate a point at which the market had ‘turned’ to head upward or downward. Pivot points can help predict where the market is going – and coupled with the resistance and support points, give you an idea how far in that direction it will go.
There are a number of ways to calculate the pivot points for the day, but the most common – and easiest – is to average the opening, closing and high points for the last day’s trading. There are other pivot points that can be calculated from those numbers as well. Before we talk about how to calculate them and what they mean, let’s define a few terms:
Pivot point – the point where the market reverses a current trend
Resistance – A high point in a market chart that recurs regularly. Generally, it’s the point where the market (or currency) will begin a downturn
Support – A low point in the market chart that recurs regularly. Generally, it’s the point where the market (or currency) will begin to climb back up.
Traditionally, support and resistance points are difficult to break through. Most of the time as the numbers approach that level; there will be a slight rebound in the other direction. An interesting phenomenon is that once a resistance or support point is broken, it tends to switch sides – a broken resistance will often become a support for prices on the other side of the line.
The most common calculation for arriving at a pivot point is:
Pivot: (High + Close + Low)/3
Resistance: 2 * Pivot – Low
Support : 2 * Pivot – High
USD/EUR Date:02/03/06 14:40 O=0.83174 H=0.83188 L=0.83167 C=0.83188
Given this data for Feb 3, 2006, the pivot points for Feb 4, 2006 would look like this:
Those numbers give me some points on which to base my strategy for the day. If the market opens above the pivot point, it’s a bull market, and most advisors would go for long trades, since the direction of the market is up. If it opens below pivot, it’s time to favor short trades and quick sales.
There are two common sales strategies using pivot, resistance and support points.
Breakout Trade: When a currency pair breaks through a resistance or support point, there’s usually a surge of activity around it. Buy if the charts show a break through a resistance, sell if the rate drops below a support point.
Pullback Trade: When the exchange rate drops back from a high, most traders will buy, based on other information that’s available. It’s a tricky move, though, since the pullback could just be a temporary pause in the upward momentum, or the beginning of a downward rebound.
Using pivot points to inform your strategy in day trading is a complex subject. You’ll find a great deal written about it by various gurus and experts. These basics can help you understand what you’re reading from them.